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episode # 5

Foreign Ownership Tax, Affordability & Why Robinson Crusoe May Hold the Key to Vancouver’s Real Estate Market with UBC Prof. Tom Davidoff

UBC Associate Professor Tom Davidoff joins Adam and Matt to discuss the BC Housing Affordability Fund and comments on foreign ownership and what makes Vancouver’s Real Estate Market so unique.

More information about the BC Housing Affordability Fund here: http://www.housingaffordability.org/

 

 

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Episode Summary


 

Intro:               Get ready for Vancouver’s premium real estate podcast. Your source for buying, selling and investing in Vancouver’s real estate market with your hosts, two guys with faces for radio, Adam and Matt Scalena.

Adam:             And welcome back to Vancouver Real Estate Podcast. I’m your host Adam Scalena.

Matt:              And I’m your other host, Matt Scalena.

Adam:             And we have an amazing episode today. We’ve got UBC Sauder School of Business, Tom Davidoff and he’s going to talk to us today about the BC Housing Affordability Fund.

Matt:              Yeah and some of you will likely have heard of the BC Housing Affordability Fund. That’s Tom and some colleagues of his from UBC and SFU’s initiative to deal with some of the challenges that impact real estate here in the lower mainland, namely foreign investment and high vacancy rate on properties that are owned by foreign investors.

Adam:             Right. But before we get to Tom’s interview maybe we should kind of talk about what’s happened this week.

Matt:              Yeah. I mean hey, there’s some big news in this week’s Globe and Mail.

Adam:             [inaudible 01:06]

Matt:              No. That’s potentially more interesting news but the news I’m talking about is an article that came out Saturday, February 6th, an exposé entitled “The real estate technique fuelling Vancouver’s housing market” which is essentially about selling assignments.

Adam:             Right. You know, the Google comes out every once in a while with a technique that’s fuelling Vancouver’s housing market. I think the last one was the technique of getting multiple offers and that’s…

Matt:              Yeah, the CBC’s covered that a few times as well.

Adam:             I don’t know if there’s any technique really fuelling our market but regardless, it is an interesting article we’re going to be talking to our managing broker at Century 21 who is an expert in all things real estate for sure and he’s going to be talking about how to dissect that article and really understand it in a future episode.

Matt:              Right. And while we’re going to get to that pretty quick and we’re going to trying to have that one out just because I think a lot of people are confused and if the comment section says anything angry about what’s going on in Vancouver real estate. So it’s going to be useful to shed some light on that subject of selling assignments.

Adam:             For sure. It’s a good thing to talk about. We also really appreciate the emails that you’ve sent in with questions and kind of directing us to this article in the Globe and Mail.

Matt:              Yeah.

Adam:             We have received quite a few emails. It’s an interesting article and I’ve seen assignment sales for many years in this market and I really do think that this has been going on for a very long time. It also seems to be more the product of a hot market. It seems to happen when the market is increasing really quickly. So I’m actually not surprised that this is an issue in a market like today’s market.

Matt:              And one that you can latch onto. But where I think that causal relationship might be wrong here is I’m not sure that selling assignments is fuelling the rising market…

Adam:             Right.

Matt:              …so much as a byproduct of a rising market where people are seeing opportunities and taking them.

Adam:             But that said there’s a lot of information that came out of that article that I think raises questions of not only assignment clauses and making sure that the consumer is protected but also about the obligations of a realtor. And there’s a lot to impact there. So I’m really looking forward to next week’s episode where – sorry, later this week’s episode. So look forward to that. So any other final thoughts before we cut to our interview with Tom?

Matt:              Yeah. I mean one thing to point out is we do actually address the exposé from Saturday February 6th with Tom and he has some interesting thoughts about it. We didn’t actually discuss it probably as much as we would have, it’s kind of exploded in the popular imagination since we spoke with him. So that’s one thing to note.

The second thing is that I think this interview is so interesting because Tom has such a holistic and nuanced understanding of what’s driving Vancouver real estate prices upward and that makes it such an interesting listen and his BC Housing Affordability Fund so compelling for sure. So without further due here’s an interview with UBC professor Tom Davidoff. Enjoy!

Matt:              Hi Tom. How are you?

Tom:                Doing very well, thank you very much for having me with you.

Matt:              Great. Thanks for joining us. So can you tell us a little bit about yourself and what your role is at UBC?

Tom:                Sure. I’m an associate professor in the Strategy and Business Economics Group. I teach real estate at the University of British Columbia. We teach a couple of MBA classes and several undergrad classes. I teach basic economics. My background is after college I worked in real estate development in New York. I got a master’s in public planning where I discovered that economics was interesting. Got a PhD in urban planning and economics from MIT. Worked for 7 years at UC Berkley teaching real estate. Came up here in 2009. Worked at the Council of Academic Advisors at the White House over the summer of 2011 dealing with the U.S housing crisis. And recently I’ve gotten interested in the situation here in Vancouver.

Adam:             So can you tell us a little bit about the BC Housing Affordability Fund and what its goals are?

Tom:                Sure. You know, one of my academic papers talks about where you want to have high property taxes and where you want to have low property taxes. And Vancouver is a place that stands out that we could have very good income and sales taxes if we had higher property taxes here and it would be a much more efficient economy. And the reason is we’ve got almost impossible building conditions which means most of the value in real estate can’t ran away from a tax.

On the other hand, as we’ve experienced, if you tax businesses and workers enough, they will run away to other places. So our tax system is sort of fundamentally misguided. Now, that’s fine. There’s nothing much you can do about that. If I were in charge I’d probably try to transition to more of a property tax and lower income and sales taxes. But the problem is making that transition is hard because you’ve got home owners who bought houses under the old rules so you’d need a slow transition to the new rules.

That said Vancouver seems to be a tax haven for people who want to speculate on real estate without caring about the dividend. Let me be clear about what I mean. It appears certainly in the last year and probably over the last 20 years that a major facter driving up housing costs in Vancouver is overseas – largely but probably also domestic – demand for real estate just as a speculative asset. When you think about real estate returns, there’s sort of two components to a return. There’s the capital gain you get from price increases and then there’s the dividend you get from having a tenant in the place.

And in Vancouver more than most cities around the world almost anywhere, the returns are dominated by capital gains because we have the famous inelastic supply and growing demand, there’s a view that rents are going to grow overtime. And by contrast, property taxes being so low mean that the dividend is going to be even smaller than it would be in a normal high capital gain’s market.

So if you look at San Francisco or L.A. or Seattle which have substantially higher property taxes but the same growth story of limited supply and growing demand, those cities have much higher rent-to-price ratios than Vancouver. When you ask yourself, what’s the difference, it’s got to be the low property taxes.

So that’s fuelling demand for real estate that essentially strips the dividend off the return. If you’re an international rich person who sort of wants a property, maybe you’ll visit it once or twice, maybe you’ll just hold it, tear it down in a few years and build something new. Giving up the dividend is cheaper in Vancouver than almost anywhere else. That’s the fundamental distortion economically here and that’s why it seems hard to understand how we get such high prices giving the income levels around here.

Adam:             So one question is, it seems like there’s a logic for why foreign investors are attracted to Vancouver. But I know generally speaking, there’s not a lot of data out there. Can you speak to that?

Tom:                Yeah. Thanks. So of course in that transition to the BCHAF proposal, so what we’ve proposed is we’re not going to have a generic property tax increase. That’s a political nonstarter, even if you compensate people with a reduction in income taxes or sales taxes. So what we’ve proposed is almost everybody is going to be held immune form a 1.5% property tax increase. The only people who are going to have to pay it are people who leave their homes empty; that is they don’t rent it out or they don’t live in it. And even if you live in it, the only way you pay a tax is if you’re not paying Canadian income taxes and you’re not a Canadian retiree and you haven’t lived in the house a long time.

So the only people who would have to pay this tax are people who have recently bought a home, don’t pay Canadian income tax from that address and don’t rent out the property. So that’s largely investors not connected to the local economy and not using the house for its dividend component. Now, a lot of people have suggested that we need something like the utilities Gestapo to count which housing units are vacant and you’ve heard the [inaudible 09:45] say, well, we’re not going to do anything about housing affordability but we will study the problem. So we’re going to spend some money and have somebody do a half big job counting how many units are underutilized which is a hard thing to do.

Our proposal is much better in that dimension. Why? Because the province or the municipalities, whoever annexed our proposal gets money, right? You charge everybody a tax and the only way you don’t pay the tax is if you take a box that says why you’re exempt. And the exemptions are easy. You’re collecting CPP funds. That’s easy. That’s very measurable. You’ve paid more income tax than you would owe in this property tax. That’s easy to measure. You’ve lived in the house and reported it as your tax home for 5 to 10 years, that’s easy, you can do that. You say how much money you sent in to inform the Canada Revenue Agency about your rental income, again, totally easy for the property owner. There’s nothing hard for the property owner. But it’s information the city and the province don’t seem to have at a property specific level. So the home owner of course wants to provide that information accurately because it’s easily verified and they can’t take it very easily.

So it’s costless almost to the home owner and it’s not costless to the province and to the municipalities because the province and municipalities actually collect money on those units that are subject to the tax which we’ve said should be sent in lump sum checks to everybody who lives and works around the lower mainland. So we find out how – what the extent is of nearly vacant units and we provide money to help people who are struggling with affordability.

Matt:              The lump sum payments you’re talking about; is that based on income or is it just across the board equal payments?

Tom:                Well, our proposal – what we think it would be the easiest is if you declare your given address as your tax residence, then you share it equally in the revenue raised. So if there were a 100 people and a $100,000 raised, everybody who has reported a tax home, every household reporting a tax home gets an equal share so that would be a 100 people sharing a 100,000 bucks, it would be a 1000 bucks to have.

Matt:              Okay and one of the – you know, there’s a cast of culprits that are usually trodden out, right, in Vancouver real estate and I’m sure you’ve had this question more than once about this potentially unfairly targeting certain ethnic groups and how do you respond to that?

Tom:                I think that’s a great question. You know, our proposal is less targeted based on nationality than anything that’s out there. So for example the home owner’s grant in British Columbia, when I was a foreign home owner my first couple years here in BC I didn’t get to claim the home owner’s grant based on my nationality. By contrast, under our proposal – because I was paying high income tax, I would have been exempt from the BC housing affordability surcharge in my first year as a home owner. And whether I’ve been from Canda, China, the U.S, Mexico; it doesn’t matter as long as you qualify under any of the exemptions, you’re exempt. Your nationality has nothing to do with what we’re proposing. It’s just whether you’re using the home to house somebody who lives and works around BC or has lived and worked around BC.

Adam:             So what kind of impact do you see this having on foreign investment? Is this going to deter people?

Tom:                Yeah, it’s a great question. You know, people who invest to hold real estate and rent it out which is the natural thing for invest that you do, doesn’t lose anything. If anything, the property becomes more attractive because whoever rents the property is now entitled to a check. The only type of investor who would become less interested in property is one who finds it just terrible the idea that you would actually rent out an investment property. If you really just love property held vacant or you want to use the property to live in occasionally, your house some of your family part of the year, the property could become a little bit less attractive, it’s true.

So we think there’s a modest negative effect on foreign investment demand. We don’t know how big a fraction of the market it is and we don’t know how big of a fraction would be deterred from investing. It seems like there’s a very long line of people waiting to invest right now from China but probably inevitably from the rest of the world because of the current low property tax system that would be available to a landlord.

So I don’t think we’re going to chase away foreign capital entirely. There might be a bit of a negative effect which could dampen prices but on the other hand we’re making it more attractive to live and work in Vancouver. The money goes somewhere and it just goes to people who live and work here. So on balance we think it would have a moderate effect on housing prices.

Matt:              A moderate effect. Okay. Because that was my next question that there’s obviously a lot of people that have their most of their equity tied up in their property so that is the big question. Do you see this having an impact on housing prices?

Tom:                Yeah. The BC liberals have insisted that any proposal they support can’t be devastating to home equity. And we tailored our proposal so that there’s an upside to people who live and work here. And there’s only a downside to investors to the extent that they just hate the idea of having somebody rent their property from them. So we think on balance again, it’s a pretty modest effect on prices so we’ve satisfied the goal of not trashing local property prices and harming people who have of course up to a 1000% of their wealth tied up in their homes.

Adam:             Right. How has your proposal been received?

Tom:                Well, you know, the problem with Vancouver today is that it’s a tax haven where investors come and strip the housing function off of housing units and that is clearly the reason we’ve seen price increases recently. And it’s also very likely what’s going on behind large rental increases. So if you want to address affordability, you’ve got to address Vancouver’s status as a tax haven where it’s attractive to strip the housing function off of houses.

So everybody we’ve talked to I think after – at the end of the conversation realized this we’ve got the only serious plan to address affordability in British Columbia. We talked to the province, we’re talking to mayor’s office soon. The opposition, David Eby has been very supportive. We’ve met with Horgan who’s also supportive. We have not heard a serious objection from anybody and every conversation we’ve had has ended very positively. You know, the thing you worry about is the budget’s coming up and recently people are talking about flip taxes. They’re saying don’t tear down houses and build luxury houses. Those are fine but they’re not going to address affordability.

So we need people not to get distracted by small issues and look at the fundamental underlying issue that’s driving unaffordability. And that’s the tax haven status of Vancouver which we address in a sort of surgical way that leaves most home owners without facing any penalty.

Matt:              Great. So there’s an article in the Globe and Mail, a day or two back that spoke about assignments of contracts and flippers. So you see that as a fairly minor element in the price increases?

Tom:                Yeah. I mean, what’s the problem? They’re worried that home owners aren’t getting enough money in these sales for their houses…

Matt:              Yeah. Exactly.

Tom:                That’s the number 1 problem of affordability in Vancouver is that grandma is going to get ripped off and sell her house for 5 million instead of 6 million dollars. No, that…

Matt:              That was my impression.

Tom:                Yeah. Yeah. There’s nothing wrong with assignment. And look, if the property is appreciating 20% in 6 months, it worth 40% probably in the last 6 months in some neighborhoods over the period between the day which this contract, the purchase and sell has been executed, the day of closing the property might have gone up 20%. There’s no reason somebody who is a speculator wouldn’t want to flip it over that period.

Matt:              Right.

Tom:                And if you band that, all you’d be doing is subtracting value from the property which hurts the home owner. So this is a symptom. Look, you know, I haven’t heard a lot about flipping in Winnipeg or Des Moines, Iowa or Wichita, Kansas. And the reason we don’t hear about flipping there is you would be crazy because you can’t make any money on flips in a market where there is surging demand. So this is the great example what you just mentioned of people taking their eyes off the ball and getting focused on a small symptom, not the underlying problem.

So yeah, flipping maybe not the greatest thing in the world but that’s not the underlying issue related to affordability. And it’s incredible that as we get near budget day people are actually getting worked up about it.

Adam:             Yeah. It seems like there is a causal argument in that Globe and Mail piece that didn’t really make sense. You know, we’re in real estate but the realtor and the speculators were somehow driving the price up as opposed to…

Matt:              General market conditions.

Adam:             Yeah, general market conditions.

Tom:                Well, exactly. And you just saw Adrien [inaudible 18:51] a protest rally saying people building luxury homes is what’s driving up housing prices like the – you know, again, somehow I don’t see in Winnipeg and Des Moines, Iowa a lot of teardowns and building luxury mansions. And there’s a reason it’s happening in Vancouver, not Iowa and not Manitoba. So let’s focus on the underlying economics and not get hung up on symptoms.

Matt:              So getting back to the model, so is there a different model that you can kind of point to where you guys took ideas or has something similar been used elsewhere?

Tom:                Yeah. So I mean we’re just using basic principles of taxation which are you audit tax goods that don’t run away from a tax and more likely tax things like income, sales etc. So that’s the basics. And we’re moving a step towards tax rationality. So I mean people have written this for a 100, 200 years since they began studying economics. So there’s nothing really new there.

Then the question is do other places favor one type of real estate owner relative to outside investors? And the answer is of course, absolutely. The home owner’s grants in BC, ours is a much more generous set of exemptions than offered by the home owner’s grant. So right here we’re just extending a tax favoritism that exists but being more generous to outside investors and not targeting nationality. There have been owner [inaudible 20:19] restrictions based on nationality and high taxes in places like Hongkong and Australia. The U.S has many, many ways in which home owners are given favoritism over landlords in real estate.

Again, ours is much more generous because we treat landlords just as generously as home owners and in the U.S. to get these exemptions you need to be a rich home owner because working class home owners don’t actually benefit from the mortgage interest deduction and property tax deduction in the U.S tax code.

So lots of places have done sort of more austere and tough penalties for investors in real estate. So ours is actually quite modest. We’re taking a step away from the tax haven status for Vancouver but not eliminating it for investors.

Adam:             Following that based on sort of a global understanding of Vancouver as one of these superstar cities emerging for the global lead. Do you see Vancouver as a place that is much more attractive than say London or Paris or Sydney?

Tom:                Well, you know, look. London is an incredible place to make money. Paris is a cultural center. Sydney is I think – I haven’t been but I think it’s got a lot of the natural appeal of Vancouver but much better weather. So what’s remarkable about Vancouver is we’ve got $1000 a square foot prices without rents that have yet caught up. And my concern is Vancouver is going to become unaffordable on the dimension of rents. But because of the lack of income and earning potential here the really striking thing you see here is the rent to price ratio is just so very low and that of course has a lot to do with our property tax structure.

Matt:              Do you have any thoughts on AirBnB and sort of tourism in Vancouver in relation to the dollar?

Tom:                Yeah, AirBnB is an interesting phenomenon. I’ve been surprised at the sort of underlying demand for short term rentals. If you look at it it just seems like a lot of market sustain and an awful lot of AirBnB units at pretty attractive prices. So it maybe as attractive to be an AirBnB host as it is to be a landlord. That has surprised me. I don’t think the numbers – and I’ve actually been on the record on this – I don’t think the numbers yet show AirBnB to be an important driver of unaffordability but you know if trends continue, it’s not out of the question.

Adam:             One last question just in terms of the level of data with – and I asked before about foreign buyers and the lack of data. How do you respond to people that might say that this tax is putting the cart ahead of the horse?

Tom:                Well, I guess – one thing to say is if you don’t think foreign investment is an important driver in recent price trends in Vancouver, than I’ve got a liquefied natural gas facility to sell you. That would be one way to say that.

Matt:              Fair enough.

Tom:                The other is there is a lot of uncertainty. You know, we put a lowball estimate in terms of how much revenue we could raise of 90 million dollars. If you take other projections sort of based on the work David Eby did, you could be as high as $3,000 per household in Vancouver so we’d be able to pay a month of rent in a pretty nice place for every household in Vancouver with the BC Housing Affordability Fund. We don’t know between like a small amount and a huge amount how much could be raised. But the beauty of our proposal is we find out while doing something about something that we know is a problem, we just don’t the know the extent to which it’s a problem.

And let me just add as a final thought, you know, people talk about the problem of foreign investment. I think we should talk about it as an opportunity. Think about Robinson Crusoe on his island. Now, his man, Friday probably wasn’t so happy about foreign investment when Robinson Crusoe arrived. But now Robinson Crusoe supposed there’s a luxury ship full of tourists off to his island. And those guys have indicated an interest in buying property from Robinson Crusoe and his man, Friday. Robinson Crusoe shouldn’t throw rocks and sticks at the guys on the tour boat because they can give them caviar and bananas and other delicious things that he’s really probably really hungry for. Okay?

So it’s an opportunity that these guys that have arrived wanting to give wealth for the land on the island. The problem is this is the sort of goose that laid golden egg but it’s not laying a golden egg on the head of renters. It’s laying something else on the head of renters. So how do we address that? Well, our proposal takes some of the benefit that’s accruing to home owners through capital gains and redistributes it if you like to everybody struggling with affordability.

So let’s think about foreign investment as an opportunity. Let’s not get up in arms. Let’s say we’re not going to cut a stupid trade deal with China as Donald Trump likes to say. We’re going to actually reap the benefits of our tremendous real estate. So foreign investment is a good thing in Vancouver. It’s only a bad thing to the extent that politicians are too stupid and lazy to deal with it in an appropriate manner.

Matt:              Perfect. Well, we’ll leave it there. Well, thank you so much for your time Tom.

Tom:                Total pleasure.

Matt:              Okay. Have a great day. Take care.

Tom:                Yeah. Bye-bye.

Adam:             So there you have it folks, our interview with UBC Sauder School of Business professor, Tom Davidoff.

Matt:              And his boy, Friday.

Adam:             One of the better analogies I think that I’ve heard about the Vancouver real estate market.

Matt:              Such an interesting guy. It was great.

Adam:             For sure. So Matt, how can people get a hold of you?

Matt:              You can get a hold of me at 778-847-2854 or at matt@scalenarealestate.com.

Adam:             Or you can try me at 778-866-4574 or adam@scalenarealestate.com. You can also reach both of us on our nonpartisan email info@scalenarealestate.com

Matt:              And please do us a favor if you liked this episode, please go to iTunes and give us a rating.

Adam:             Yeah, it really helps.

Matt:              And also subscribe because we’re really still trying to get the numbers up and going.

Adam:             Yeah, we’re trying to grow this thing and hey, we have another episode soon with Mike Hofer that’s going to be great so you want to subscribe.

Matt:              For sure. For sure.

Adam:             Don’t miss that one. And also if you like it, share it with your friends. Have a great week. Take care.

Outro:             This has been the Vancouver Real Estate Podcast with Adam and Matt Scalena. Contact us anytime at 778-866-4574 or 778-847-2854. Or online at www.scalenarealestate.com. Subscribe today.

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